How does the step-up in basis at death work?

What it is

When you inherit property, your cost basis is generally reset to the property's value on the date of death. Unrealized gain during the decedent's life is therefore not taxed as income when heirs sell. If the property has declined in value, the basis goes down instead.

The adjustment is automatic, but you need evidence of the value, such as statements and appraisals, to support the basis you report when you sell.

The rule applies to most assets: stocks, real estate, business interests, collectibles, and personal property. It does not apply to assets that represent income the decedent had already earned but not yet received, which remain taxable to whoever receives them.

What the law says

IRC §1014(a)(1) provides that the basis of property acquired from a decedent is its fair market value at the date of death, unless it was sold or otherwise disposed of before death. Section 1014(b) lists property treated as acquired from a decedent, including property in a revocable trust (§1014(b)(2)) and the surviving spouse's half of community property if at least half of the whole community interest is included in the decedent's gross estate (§1014(b)(6)).

Section 1014(c) excludes items of income in respect of a decedent under §691, such as traditional IRA balances. Section 1014(e) denies a step-up for appreciated property the decedent received as a gift within one year of death if it passes back to the donor or the donor's spouse. Under §1014(f), the basis a recipient uses cannot exceed the value finally determined for estate tax, and §6035 requires executors of estates that must file Form 706 to furnish Form 8971 statements.

Rev. Rul. 2023-2 holds that assets in an irrevocable grantor trust that are not included in the grantor's gross estate do not receive a §1014 basis adjustment.

Requirements and tests

If the executor elects alternate valuation under §2032, basis is the value six months after death, or the value on the date of an earlier sale or distribution. The election is available only if it reduces both the gross estate and the estate tax.

For real estate and business interests, the appraisal should be dated as of the date of death, prepared by a qualified appraiser, and kept with the estate records. For publicly traded securities, value is the mean of the high and low trading prices on the date of death.

• The property is acquired from or passes from the decedent within §1014(b).
• The property is not income in respect of a decedent and not caught by the one-year rule.
• Value is documented: date-of-death brokerage statements, qualified appraisals for real estate and closely held interests, and the Form 706 values if one was filed.
• If Form 706 was required, the beneficiary's basis is consistent with the Form 8971 statement.

How it works

An heir who inherits stock with a $200,000 basis worth $1,000,000 at death takes a $1,000,000 basis and has no gain if the stock is sold for $1,000,000. If the owner had given the stock away during life, the recipient would take the $200,000 basis and have $800,000 of gain on the same sale.

Texas note: for a married couple's community property, the surviving spouse's half also gets a new basis at the first death. Separately owned property and property in common-law joint tenancy get an adjustment only for the decedent's share.

When an estate is not required to file Form 706, beneficiaries still get a basis adjustment, but no Form 8971 is issued. In that case, keeping your own evidence of value is especially important, since there is no estate tax return to point to.

Risks and IRS scrutiny

Risks include missing or weak valuations, inconsistent reporting after a Form 8971 was issued (which can bring accuracy penalties under §6662(k)), claiming a step-up for IRAs or excluded grantor trust assets, and forgetting that depreciable property starts a new depreciation schedule. Estate examiners review asset values under the Internal Revenue Manual's lead sheets.

Rental property and other depreciable assets restart depreciation from the new basis, but the portion attributable to land is still not depreciable.

Who it is not for

The rule does not help with retirement accounts, lifetime gifts, or assets in trusts outside the estate. It also does not help families planning to give appreciated property now that they could instead hold until death, where a step-up would eliminate the gain.

How ebotCPA helps

We build a basis file for inherited and to-be-inherited assets, obtain date-of-death values, apply the community property rules, prepare Form 8971 when required, and compare gifting with holding for a step-up.

Book a $497 Case Analysis to have Ebot Mbi, CPA, EA review your facts before you act.

Primary sources

1. 26 U.S.C. §1014(a)(1). Basis of property acquired from a decedent.

   “the fair market value of the property at the date of the decedent's death”

   Sets basis at fair market value at the date of death.

2. 26 U.S.C. §1014(b)(6) and (c). Community property; income in respect of a decedent.

   “This section shall not apply to property which constitutes a right to receive an item of income in respect of a decedent under section 691.”

   Adjusts the survivor's community half and excludes IRD from the basis rule.

3. Treas. Reg. §1.1014-1. Uniform basis of property acquired from a decedent.

   Explains the basis rule and uniform basis among beneficiaries.

4. Rev. Rul. 2023-2. No basis adjustment for excluded grantor trust assets.

   Denies a §1014 adjustment for grantor trust assets not in the gross estate.

5. Form 8971. Information about beneficiaries acquiring property from a decedent.

   Used by executors to report estate tax values to the IRS and beneficiaries.

6. IRM 4.25.5.2.7. Community property lead sheet.

   Guides examiners on community property issues in estate returns.

Frequently asked questions